The evolution of the business of business economics

Business Economics, April, 1989 by Roger E. Brinner, Roger Winsby

The Evolution of the Business of Business Economics

DURING THE 1960s, economists devoted most of their time to adjusting their forecasts of the macroeconomy. For example, almost every client of our firm, DRI/McGraw-Hill, spent several days each month accessing the U.S. model on our mainframe computer in order to fine-tune a quarter-by-quarter forecast.

WHAT WAS OFFERED

At the time, a general perception prevailed that the major challenge was to produce specific forecasts of private sector behavior, given a readily predictable government and foreign environment. This attitude was valid during the 1960s; fiscal and monetary policy followed a regular countercyclical pattern (but clumsy and late), foreign exchange rates were fixed, Europe was mainly the place to vacation, Japan was a dime-store supplier, and the Texas Railroad Commission set the price of oil.

The most likely source of forecast error was a faulty translation of these external assumptions into private income and spending flows. However, too often it was hoped that running enough regressions would eliminate even this type of error, and thus lead to everlasting truth. In short, economists fell into the trap of specializing in quantitative output at the expense of their potential conceptual or qualitative contributions.

WHAT WAS EXPECTED

Accuracy, above all, was expected. If we could deliver on-the-mark forecasts of GNP, the CPI, the prime rate, and gross sectoral detail (such as the number of housing starts) correct to two decimal places, we NABE members assumed senior management would know what to do with it. In some instances, economists were beginning to build satellite models helping to bridge from the national economy to specific industries. At our firm, the macroeconomic data bases, publications, and models were complemented with a dozen specialized industry services. Drawing on this information, new plants were constructed, acquisitions were made, and inventories were stocked by our clients.

Thanks in part to the policy advice provided by the macromodeling fraternity, the business cycle was nearly repealed in the 1960s. Modelers came to the conclusion that optimal economic performance could be achieved by fine tuning. (The consensus was for generally conservative fiscal policy and supportive monetary policy. To adjust the composition of national spending toward a progrowth mix, investment tax credits were invented.) But good luck as much as good advice helped to avoid traditional business cycles. Defense expenditures rose just when a recession seemed imminent in the late 1960s, creating that new creature, the "growth recession." Shortly thereafter, in the spirit of fine tuning, a temporary income-tax surcharge was enacted to cool an overheated economy.

CHANGING FORECASTING CHALLENGES

Unfortunately, stability came to an end in 1970, and with the dream of perfect forecasts. Not only did economists have to predict the American consumer and business mood, they also had to foretell the behavior of OPEC sheiks, foreign finance ministers, the weather, and global business cycles. This shift meant that, even though macroeconomic forecasting was becoming a more careful science, its accuracy at first deteriorated.

We had to learn and then teach our clients that forecasts have two distinct elements: (1) the prediction of the behavior of large populations of consumers and businesses, about which the law of large numbers gives the analyst a good chance of being right; and (2) the prediction of the decisions of a particular policy maker, which is a far more difficult call because neither a long history of examples nor the benefit of a large number of actors across which to average behavior is available. As the first major dollar devaluation and the first OPEC crisis taught executives and economists alike in the early 1970s, contingency analysis is necessary to deal with the second class of forecast issues.

Nevertheless, creation of alternative scenarios is not mandatory for dealing with problems in predicting private sector responses to a given external environment. Such scenarios tend to be less valid because they too often flow from arbitrary deviations of behavior from norms established by solid statistical analysis. Still, a whole "boutique" subsector of the consulting industry has grown up around outlandish speculations and regular doomsday scenarios. These diminish the general respect accorded the economics profession because they are not scientific and because they foster the notion that economists cannot agree on fundamental principles.

CRISIS AND REPOSITIONING

When economists couldn't deliver what had become expected, the profession as a whole came under attack. The predators in the press and the executive suite enjoyed a million-and-one jokes threatening the comfort, if not the livelihood, of the genus. We had to evaluate much more carefully what information was needed by whom, and what areas of comparative advantage we had in meeting such needs. But until the 1980s, economists still clung to their old masters: planners, investment communities, and government policy makers. Our existence wasn't sufficiently threatened to stimulate our imaginations to adapt our habitat.